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Bernanke Will Disappoint On QE And Rates Will Spike After FOMC

The Fed will once again disappoint markets with its policy statement on Wednesday, according to analysts at Nomura and Barclays. Despite Bernanke’s insistence that QE3 remains on the table, analysts expect a more hawkish Fed, failing to deliver further easing while acknowledging the continued, albeit slow, economic improvement. A Treasury bond sell-off could once again push yields structurally higher, after concerns over Europe dragged them back down to sub-2% levels.

But, Bernanke’s post-statement press conference, coupled with the most recent release of FOMC members’ policy projections, could provide some surprises.

After months running the show, the Bernanke Fed has slowly moved to the background. Stronger economic data and temporary reprieve in Europe have allowed the world’s most important central bank to back-off a little and let markets do their thing.

While the situation appears to be changing, with Europe once again in the eye of the sovereign debt storm and U.S. labor markets substantially underperforming expectations in March, the Fed will probably take it easy, no pun intended.

Bernanke & Co. won’t announce any additional easing, and will maintain their pledge to keep interest rates zero-bound at least until late-2014, according to analysts at both Barclays and Nomura. Operation Twist has every chance of continuing until completion, and the Fed will continue to suggest it will review the size and composition of their balance sheet, signaling they are ready to use any tool if needed, making an indirect reference to quantitative easing.

The focus will be on Bernanke’s press conference. The Chairman will be presenting the FOMC’s updated economic projections, where Nomura expects minor tweaks, particularly the “marking-to-market” of improved labor data. (Interestingly, Barclays’ research team suggests the Fed could acknowledge labor data weakness, given March’s big miss). The bearded academic will probably face questions regarding high gas prices and further easing, with markets attentively listening to every word he says.

Market reaction to the Fed’s last statement, issued on March 13, was massive. Bond markets appeared to have finally accepted QE3 is off, for the moment, and that improved economic data meant rates could go up sooner than expected. Yields on 10-year Treasuries sky-rocketed as a post-FOMC sell-off took hold, breaking a four-month range and getting close to 2.4%. Gold prices suffered in tandem.

Those trends reversed in April, though, as the European sovereign debt crisis once again reared its ugly face. Rates have once again fallen to very low levels, trading at 1.96% by 2:25 PM in New York on Wednesday.

Analysts at both investment houses believe upside risks on rates are substantial, as markets once again re-price their rate hike/QE expectations. This move could be aided by more hawkish economic projections suggesting a greater number of FOMC participants want to see higher rates before late-2014.

The financial landscape could indeed be clearing up. Major banks like JPMorgan Chase, Citi, and Goldman Sachs beat profit estimates this earnings season, while GDP is expected to come in at 2.2% to 2.5% this year, according to Wells Fargo. Still, a massive pipeline of foreclosed homes still sits on banks’ balance sheets, forcing prices to fall even lower, as Tuesday’s Case-Shiller index showed. Consumer confidence has slipped and Europe could flare up, seriously, once again, with Spain, and Italy in the spotlight.

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